Germany isn't getting much respect

EmilyChurch

LONDON (CBS.MW) -- This week, as they periodically do, the equity strategists at Salomon Smith Barney shuffled their list of top stocks to reflect new ratings upgrades and to drop the downgradees.

The largely clerical exercise doesn't often surprise, but this time it appears there isn't a single German stock left on the European Recommended List, and this is a list that includes Spanish carrier Telefonica
TEF, +0.53%
whose shares are down 30 percent since the start of the year amid the sell-off in European telecom stocks.

SSB strategist Niall MacLeod cautions against reading too much into the omission. Fair enough, the list will change again as the firm's analysts respond to the latest trends, but the lack of representation from Europe's largest economy remains striking, even if only for a short time.

The point is Germany AG isn't getting much respect in the stock market these days.

Brunt of slowdown

Much of the concern about Germany is directly linked to the economic slowdown in Europe, which has been spreading at a more devastating clip on the Continent than many anticipated, including Germany's political leadership who had held out that the impact of the U.S. slowdown would be modestly felt.

The rise in July unemployment in Germany sparked another round of talk among the commentators that the country remains close to slipping into recession.

Meanwhile, the growth estimates for the 12 countries in the "eurozone" have been trimmed down to just below 2 percent for 2001. Pressure is again building on the European Central Bank to cut interest rates and spur growth.

"Clearly, German growth is the weakest area in Europe at the moment," said George Hodgson, equity strategist at ABN Amro.

Neuer gets alt

Only a curmudgeon could hold Germany to blame for the slowdown, but markets aren't in the business of playing nice. The criticism being leveled at the ECB for resisting the call to cut rates is likely tainting Germany as well.

There are German-specific issues too, such as the turmoil surrounding the tech-laden Neuer Markt, for a time the listing market of choice for small stocks.

The German stock exchange recently introduced rules to tighten standards on the Neuer Markt, which has seen a rise in insolvencies, but the damage has been done, said Jason Holzer, portfolio manager of the $375 million AIM European Development Fund
AEDAX, -0.05%

"We used to have a hard time finding exciting growth stocks in Germany, and all of a sudden, these small, independent-minded companies had a public outlet. Unfortunately, what you've seen is that a number of the companies haven't delivered on their promise," Holzer said.

To be sure, plenty of investors remain in Germany for reasons that range from a corporate restructuring wave to positioning for the recovery.

"There's risk in not being exposed being to Germany," said Mark Tinker, equity strategist at Commerzbank in London.

Holzer still remains more bullish on Germany, and said he has increased the fund's exposure to the country this year via auto stocks BMW (519000) and Porsche (693773) and reinsurer Munich Re (843002).

DAX weight

Yet for now, it's inescapable that the gloom is being reflected in the stock market. Germany has been a laggard against its big economy peers.

German blue chips in the DAX 30 index are down 14 percent for the year, against a 4.5 percent decline in the Dow Industrials and a 12.5 percent drop in the FTSE 100 index of the largest London-listed stocks.

The defensive stocks in the consumer sector aren't offering enough of an alternative relative to other European consumer plays, Hodgson said. "We find that analysts in the more domestic areas, such as retail, are shy of German stocks," he said.

Signs are surfacing that some may be losing patience with the pace of the restructuring.

"We have seen Mannesmann and Vodafone
VOD, +0.80%
(merge) and Allianz (840400) take Dresdner Bank, but relative to the rest of Europe, Germany is behind the curve," said Hodgson. Bayer (575200), a chemicals and pharmaceuticals maker, is a case in point, he said.

Expectations that the company would restructure assets to confront the weakness in its markets have yet to be met, he said. Bayer on Friday did however reveal it was mulling at least a joint venture for the pharma unit. See story.

Bright spots

To Tinker, the bank, utility and industrial-tipped weightings are overshadowing some "good stories" in German equities.

"DaimlerChrysler
DCX
(710000) and BMW have done very well in the U.S. market partly because the U.S. market hasn't been as bad as the doomsayers predicted, but also because of the competitive advantage of the euro," he said.

German midsize stocks continue to generate interest, he said. "There's a lot going in the smaller size companies under the $1 billion level that is capturing the imagination," he said. Holzer agrees and said his fund is equally invested in the smaller caps in Germany.

Given the disappointment for German cyclical stocks and the pace of restructuring, more attention is likely to be paid to the third leg of the German stock story this year: tax reform.

It is here that enthusiasm for German stocks is likely to rekindle this fall. The country is in the midst a tax reform scheme that will allow corporations to unwind massive shareholdings in other German companies.

"The reason for buying is valuation. An awful lot of capital is getting loose that's going to start generating a return," Tinker said.

Intraday Data provided by SIX Financial Information and subject to terms of use. Historical and current end-of-day data provided by SIX Financial Information. All quotes are in local exchange time. Real-time last sale data for U.S. stock quotes reflect trades reported through Nasdaq only. Intraday data delayed at least 15 minutes or per exchange requirements.